Kohler Target $3.22

FXL FLEXIGROUP LIMITED Buy $2.30 $3.22 High
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Flexigroup (FXL)
Flexigroup Limited announced a 7.25 cent fully franked interim dividend. Shares will trade on an ex-dividend basis on the March 9, 2016, and proceeds will be paid to eligible shareholders on the April 15, 2016. This dividend amount was very close to our expectations for 7 cents, but is lower than that paid in previous years.
The reason for the lower dividends in FY16 has been well flagged to the market and relates to the need to pay dividends to additional shareholders as a result of the rights issue associated with the acquisition of Fisher and Paykel Finance (FPF), which is expected to be completed in a few months’ time. FXL management were clear to emphasise that the reduced dividend is seen as temporary, and a reversion to a higher level will be expected in coming periods as earnings from FPF begin to contribute to cash profits.
Despite this timing issue being a slight negative, the longer term opportunity and growth prospects for FXL remain in place, and the completion of the FPF acquisition will be a key catalyst for both earnings and dividend growth. There are still challenges at FXL with funding markets tightening, and volumes in some segments weakening. That said, the share price reaction to the result was quite pronounced, and in my view unwarranted.
Highlight and key challenges
FXL grew cash net profit after tax (Cash NPAT) by 4 per cent when compared to the first half last year, from $42.5 million to $44.3m. The growth was driven by a 5 per cent lift in sales volume with the highlights being the Interest Free Cards business, and the NZ leasing business (though this was driven by the acquisition of TRL). The Australian Leasing business (a combination of the divisions previously reported as Consumer, SME and Enterprise) was a clear laggard for the company, as the business restructures its team, and saw declines in both volumes and receivables. In particular, the Rent smart product runoff, and a slightly weaker than anticipated performance in the Enterprise business led to lower volumes, receivables and Cash NPAT contribution. In my view this division may take some further time to recover back to previous volumes and profit contribution, and is a key area of challenge for the business.
Aside from this, there is some macro risk emerging for FXL. The company’s cost to income ratio was very well managed in the first half at 39 per cent, down from 41 per cent in FY15. However, this could be attributed not only to good cost control but to the absence of a chief executive salary – something which will not continue with the appointment of Symon Brewis-Weston. Despite this, the market appears to have funding cost concerns as securitisation markets have tightened in recent months. With FXL likely to need to securitise some Certegy receivables later in the year, there is an expectation that the cycle for lower funding costs is near a bottom. Here are two charts of FXL’s cost to income ratio and funding costs over recent years:


Source: FXL 1H16 results presentation
In my view, these two metrics are likely to be near a bottom, leading to the conclusion that profitability may be more challenged in coming periods. However, the market response to these concerns has been overly emphasised. The group still continues to grow in terms of top line, and with the acquisition of FPF expected to produce a minor second half contribution and strong lift to earnings and dividends in FY17, these concerns appear overdone at current price levels.
Key take-away and outlook
This result was well flagged by management, and in my view was of little surprise. The Australian leasing business was perhaps slightly weak than anticipated, impacting the overall cash net profit. Additionally, volume was soft in Certegy (the no-interest ever lending business), which accounts for around 40 per cent of revenue.
That said, the company reconfirmed its guidance for full year cash NPAT between $92m and $94m excluding any contribution from the FPF acquisition. With a first-half result of $44.3 m in cash NPAT, achieving this guidance would suggest an expectation for a stronger second half. All in all, the result was solid, but uninspiring. The real catalyst will come in the FPF acquisition, and we remain comfortable with our buy recommendation. We have adjusted our expectations for organic growth in the existing FXL business downwards. With building cost pressure and a chance that macroeconomic influences will provide challenges, it is the prudent assumption. This leads to a lower valuation of $3.13, down from $3.22. Once the FPF acquisition is complete, we expect that FXL management will provide a further guidance update to the market, which is expected at the beginning of April. Investors should watch for interest rate and unemployment data for further potential influences to the outlook.